Cash and Receivables Study Notes
CHAPTER 6: Cash and Receivables
Overview of Cash and Receivables
Definition of Cash:
Cash consists of coin, currency, funds on deposit at banks, and negotiable instruments such as money orders, certified checks, and personal checks.
Cash Equivalents: Financial instruments that can be readily converted to cash. They must be:
Readily convertible to known amounts of cash.
Close to maturity to prevent significant changes in value due to interest rate fluctuations.
Examples include Treasury bills, certificates of deposit, commercial paper, and money market funds.
Definition of Receivables:
Claims against customers and others for money, goods, or services. Examples include:
Loans (e.g., a bank lending money to a company).
Accounts receivable (e.g., selling goods on credit).
Importance of Cash and Receivables
Liquidity and Financial Flexibility:
Key for meeting obligations. Investors and creditors analyze cash and receivable data to assess whether a company is efficiently managing its assets.
Trapped Cash example: A discussion about Apple’s cash reserves, highlighting the importance of cash management and investment opportunities.
Accounting for Cash and Receivables
6.1 Cash
Companies classify cash as a current asset in financial statements. To qualify as cash, an asset must:
Be available for current obligations.
Be free from contractual restrictions.
Cash Reporting Issues:
Restricted Cash: Cash designated for a specific purpose and reported as current or long-term assets based on when it becomes available.
Bank Overdrafts: Reported as current liabilities, usually added to accounts payable unless offset against available cash in another account.
6.2 Receivables
Classification:
Current vs. Noncurrent.
Trade vs. Nontrade receivables.
Types of Receivables:
Accounts Receivable: Oral promises to pay, usually collected within 30-60 days.
Notes Receivable: Written promises to pay on specific future dates, may include an interest component.
Recognition of Accounts Receivable:
Recognized when control of goods or services is transferred.
6.3 Valuation of Accounts Receivable
Uncollectible Accounts:
Direct Write-off Method: Records bad debt expense when a specific account is identified as uncollectible.
Allowance Method (GAAP): Estimates uncollectible accounts. Key features include:
Estimating totals based on current and historical trends.
Allocating estimated uncollectibles to the Allowance for Doubtful Accounts.
6.4 Notes Receivable
Recognition:
Long-term notes accounted for at present value of expected cash flows. The value can be adjusted based on interest rate differences:
If face value and market rates conflict, notes may require premium or discount calculations.
Zero-interest-bearing Notes: Imputed interest is included in the discount.
6.5 Other Issues
Disposition of Receivables
Sale of Receivables (
Factoring):Without Recourse: Seller bears no credit risk; loss recorded as a loss on sale.
With Recourse: Seller retains some risk, recognizing a liability.
Financing Options and Loans: Borrowing against receivables or selling them to improve cash flow.
Measurement Issues and Presentation
Accounts Receivable Turnover: Provides insight into how quickly receivables are collected.
Average Collection Period: Takes the accounts receivable turnover and divides by 365 days to determine average days outstanding.
Bank Reconciliation: Necessary to ensure accuracy of cash balances; includes transactions like deposits in transit, NSF checks, outstanding checks, and errors.
Appendix 6A: Cash Controls
Cash Management Techniques:
Use of multiple bank accounts for control.
Petty cash system for small, daily transactions.
Physical and procedural controls to safeguard cash.
Bank Reconciliation: Key for accurate cash reporting and discrepancy management.
Conclusion
Understanding accounting for cash and receivables is essential for measuring liquidity and financial health. Effective accounting practices ensure compliance and provide insights into operational efficiency, improving decision-making for stakeholders.